Are Macro Conditions Favourable to Frontier Markets in 2017?
We are just over a month into 2017 and we have seen some interesting trends emerge already. Here are 4 thoughts on how frontier markets will be impacted by major macro trends we have seen so far.
1. The Reflation Trade Is A Mixed Bag For Frontier Markets
The Trump reflation trade has dominated the news cycle since his election victory, and is the main reason cited for US stocks performing well over the past quarter. Simply stated, his policies are expected to increase both growth and inflation, and push interest rates higher as a result. This has been a net positive to equities at the expense of bonds. The reflation trade mostly helps developed nations that have suffered from low growth despite low rates, as it signals the end of the zero bound era of interest rates. This is partly why European stocks have done so well to start the year. However, for frontier markets, the impact is much more mixed.
The Good: From an asset allocation point of view, US stocks have dominated international and EM stocks over the past couple decades. Every year, we look at US valuations vs the world and hear that this is finally the time it will turn, but could the reflation trade actually change this trend? We have already seen International stocks outperform the US to start the year, and EM stocks as an asset class had a big rebound year in 2016. If this is the beginning of a trend, then you could expect more developed Frontier Markets, such as in Europe or the Middle East, to outperform.
The Bad: The reflation trade does little to help frontier markets where growth, and particularly inflation, are high. This is particularly negative for frontier market bonds, since if yields in the developed world are moving higher, the search for carry will stay more at home.
2. The Commodities Look To Have Based
Last year we already saw a bottoming out in commodity prices, but the reflation trade has given further support to commodity prices worldwide. With inflation becoming a bigger fear, gold has once again surged to start the year. Higher growth also implies a greater demand for natural resources again. This is a net positive for many of the heavy commodity producers in frontier markets, particularly in South America or the Middle East.
3. The US Dollar Looks To Be Capped
The USD has underperformed in 2017 after a strong bull run in the years prior. The main reason has again been President Trump talking down his own currency, particularly against large trading partners like the EU and China. If the USD is unable to rise much in early 2017, this boosts local currency returns for frontier markets around the world, reducing the currency risk inherent in an international portfolio.
4. Is Political Risk Overrated?
Trump’s election victory has not caused a bear market. The Philippines, post Duterte, has bounced back strongly in 2017 after moving lower in 2016 after his election. Even the EU, with a lot of political risk from upcoming elections, has been home to stellar stock returns so far this year. This all begs the question, is political risk in fact overrated when it comes to portfolio performance? Volatility and nervousness have increased, but so far anyone who has sold off a portfolio due to an election result has not fared well. It is interesting that pro-business policies have trumped any affects from nationalism and anti-trade policies so far. It is a trend worth monitoring, but could bode well for frontier markets where political risk results in a significant equity premium.